New role for credit card payments in credit scores

by Peter Andrew

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Up until now, it's not been hard for those with credit cards to understand how to avoid their plastic having a negative effect on their credit scores. All they had to remember was:

Make every payment (at least the minimum due) every month on time.

Keep balances below 30 percent of the cards' credit limits. The lower that percentage the better, but the difference 10 and 20 percent make to your score compared with 30 percent is minimal.

Apply for new credit cards only when you need them. Having lots of recently opened accounts of any sort may be harmful.

Observe those three rules, and you'd have every reason to expect your cards to help rather than hinder your achievement of a good or great credit score.

Credit cards and scores: New factor

But now a new factor might soon affect your score, according to a recent report from The New York Times. It suggested that at least one of the Big Three credit bureaus was already using the amount by which you pay down your cards each month to help calculate your score. Other bureaus and scoring companies may well follow suit.

The purpose of this is to differentiate between "transactors," who pay down their balances in full each month, and "revolvers," who routinely carry forward ("revolve") balances from one month to the next. The theory is that transactors are likely to be more creditworthy, and so deserving of higher scores, though a FICO spokesperson told the Times that it was still studying the data, and was yet to change its systems. FICO is the company whose credit-scoring technologies are used in over 90 percent of lending decisions in this country.

If FICO and others in the credit-reference industry do in future begin to differentiate between transactors and revolvers, it could see the latter's scores being downgraded even if they always make minimum or higher credit card payments on time every month. And that could see a significant change in how people view their plastic.

Credit card companies likely want status quote

This could be bad news for credit card companies, because it could result in fewer revolvers. After all, would you use your credit cards to borrow if you knew that was likely to make your home, auto and other loans more expensive?

And the interest those who roll forward balances pay represents an important revenue stream for these purveyors of plastic. Indeed, within the card industry, transactors are known, unflattering, as "deadbeats," because those who never borrow generate little profit.

Credit scores like ketchup and ice cream

People talk about "your credit score," but in fact pretty much everyone who has one has many. There may not be quite as many varieties of these as Heinz has, nor flavors as Baskin-Robbins, but it's perfectly normal for an individual to have a couple dozen.

There are three main reasons for that:

Some lenders prefer to use older versions of FICO and other scoring applications, sparing themselves the expense of upgrading their systems. So they may use scores calculated slightly differently.

Scores are often often customized so that they're especially good indicators for particular types of borrowing. So the score auto loan lenders see for a particular consumer may be different from the ones supplied to credit card companies, which may be different again from the ones viewed by mortgage lenders.

There are three main consumer credit bureaus (Equifax, Experian and TransUnion), and, although they all use FICO and probably VantageScore technology, they each tweak calculations to provide their own proprietary versions of your score.

Of course, the factors that create a good or great credit score remain the same, and whichever of your score or scores a lender views, it's likely to reflect your past behavior. But it is worth being aware that, when you access your own score, the one you see may be different from the one used to decide whether to lend to you -- and, if so, at what interest rate.

More to come?

Using your status as a transactor or revolver to help calculate your score may be just the beginning. Although the companies behind scoring systems are likely to be conservative about change, so as to maintain the credibility and predictability of their products, they are also constantly looking out for ways to better satisfy the credit card companies and other lenders who pay them.

Already, FICO is working on so-called big data concepts, though these are currently intended to help clients with marketing rather than credit scoring. But, over the medium and long term, we might see all sorts of new factors affecting our perceived creditworthiness.

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